Outlook: Falling prices don't mean deflation

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The Independent Online
Commodity prices are falling, the strong pound is keeping imports cheap, and industry is so deep in the doldrums that manufacturers stand no chance of pushing through increases in the price of their products. The circumstances could not be more favourable for keeping inflation low, as yesterday's figures seemed to confirm.

Add to that picture the possible effects of the Asian financial crisis on world-wide growth and the expected slowdown in the US, and it is perhaps not surprising that some pundits have started to predict deflation - falling prices in absolute terms - for the first time since the Great Depression. Not surprising, but premature. Inflationary pressures are probably weak enough to make deflation more of a possibility now than at any time in the past 60 years, but even so the deflation fear stems seems to stem more from over-generalisation than anything else.

Start with the Asian effect. The fall in Pacific Rim exchange rates, combined with a glut of some of the products they produce, such as semiconductors and cars, is dramatically cutting the sterling cost of these goods. But this probably doesn't mean a massive flood of cheap imports. The Asian economies are in no position to buy the imported materials, get the trade credit or invest in the extra capacity they would need for this to happen.

The price of some some goods and services - communications and IT in particular - is falling rapidly, and their quality improving. But this isn't deflation either. It is a change in relative prices that always graces goods at this stage in their life-cycle. It happened with TVs and cameras too. Cheaper consumer electronics did not mean that prices across the economy as a whole started to fall in the 1960s. The price of wages - much less well behaved than the price of goods - is the more important signal.

Besides, against this incredibly favourable background, the UK still manages to have underlying inflation above-target and above the rates in almost all the rest of the industrialised world. It is still too early to relax completely about meeting the 2.5 per cent inflation target, never mind start worrying about deflationary dangers.